By Ryan O’Donnell, CFP® and Mike O’Donnell, CFP®
It’s summertime. Many of us are traveling or busy with kids and family plans. But we’d love to catch up with you, hear what you’re up to and talk about anything that might be on your mind.
We’re not going to sugarcoat it. The 2nd quarter (ended June 30th) was pretty negative in terms of returns for stocks, bonds and most other asset classes. You have to go back to 1970 (-21%) to find a time when the markets had a six-month decline as steep as we just endured. And you have to go back to 1969 to find a time when both stocks and bonds were in negative territory during the same year. Just remember, three months is a very short time in the investment world and the market has a short memory.
Case in point: Despite a terrible first half in 1970, the markets bounced back with a gangbuster 2nd half (+27%). We’re not saying 2022 will be the same as the 1970s; We’re saying that markets are unpredictable in the short term. It’s easy to look back and say: “Well, of course inflation was coming, or of course the stock market was too high.” But people have been saying that for years.
It’s the “unexpected” things – the outliers -- that rattle the markets. Few expected that Russia would go through with its threatened invasion and occupation of Ukraine. Few saw the Fed raising rates three times faster than anticipated. These are the unexpected things that jolt investor confidence and move markets. If you rewind the tape to the three most turbulent markets we’ve had recently, you’ll see they were ignited by extreme outlier events: A COVID lockdown in 2020; a global financial crisis in 2008 that almost brought down the entire banking system; and a terrorist attack on the Twin Towers and Pentagon in 2001. Did anyone honestly predict those tragedies? Nope.
We’re not saying there isn’t more bad news ahead, but we can also benefit from positive surprises. What if China decides to side with the United States and removes Vladimir Putin from Russia? That could end the war and create a highly beneficial alliance between us, China and Europe. Suppose a new drug is developed that cures cancer, or a new technology emerges that eliminates the need for fossil fuels and makes energy and effectively free? If any of those things take place, there would likely be a giant boom for the stock market. Will they happen? We don’t know. But when you’re in the predicting game your often wrong.
As baseball great Yogi Berra liked to say: “It's tough to make predictions, especially about the future.”
So how did the markets end up in Q2? U.S. stocks, as measured by the S&P 500 were down 16.7% for the quarter while the U.S. bond index was down 4.69%. Again, only twice since the Great Depression have U.S. stocks and bonds finished the year in negative territory at the same time. It hasn’t happened since 1970 and we don’t see it happening again in 2022. In fact, the average return for the market following a 20% (bear market) decline since the Great Depression has been +22% after one year + 41% after three years and +72% after five years. More on that in a minute.
Major headlines for Q2:
Mortgage rates hit 5% for the first time since 2011.
U.S. inflation hit a four-decade high.
The Fed raised interest rates 0.50% -- its largest rate hike since 2000.
The Fed raised interest rates AGAIN. The 0.75% hike was the largest single rate move since 1994.
The markets posted their worst first half in four decades (see above).
We suspect many of you were caught off guard by the weak performance of bonds during the first half. Conventional wisdom is that bonds are a safe haven for your money during times of stock market volatility. While the depressed valuations of bonds may be disturbing, it’s important to remember that bonds are not stocks. Bond values change based on two separate factors -- credit and interest rates. The credit has not changed. Companies we loan money to are not nearing default. The real change has to do with interest rates, which means it’s an opportunity cost: Am I better to take a loss today to get more interest, or am I better off holding my investment and earning less interest? Either way you will come out ahead.
If you review the Fed’s last five major rate hikes, short-term bond prices decreased each time, averaging 4.5%. Investing in bonds is still about minimizing the volatility of equities and providing yield. That hasn’t changed.
Recession
It’s hard to discuss the near-term future of the economy and financial markets without mentioning the dreaded R-word. But, as our colleague Marlena Lee, Ph.D. explains, a recession is not necessarily a reason to sell. In fact, it may be a good time to buy. Are we headed into a recession? “A century of economic cycles teaches us we may well be in one before economists make that call,” wrote Lee. “One of the best predictors of the economy is the stock market itself. Markets tend to fall in advance of recessions and start climbing earlier than the economy does.”
As the old saying goes: “Economists have predicted 9 out of the last 5 recessions.”
Market returns are often positive during a recession. If nothing else, history teaches us that you want to remain invested at times like these and not try to get in and out of the market. “When stocks have declined, it might be tempting to sell to stem further losses” noted Lee. “You might think, ‘I’ll sit out until things get a bit better.’ But by the time markets are less volatile, you’ll have often missed part of the recovery. Yes, it stings to watch your portfolio shrink, but imagine how you’ll feel when it’s stuck while the market rebounds,” Lee added.
Finally, now may be a good time to reassess your portfolio and your plan. Beyond having a well-designed portfolio, one of the best ways to deal with volatile markets and disappointing returns is to have planned for them. A financial advisor can help you develop a plan that bakes in the chances you’ll experience some market lows. And they can help you find the confidence to weather the current storm and get to the other side.
Conclusion
We hope you’re staying safe and healthy. Again. If you have a question or just want to review your performance, please contact us HERE to schedule a quick meeting with either Mike or Ryan.
